Thousands of City jobs are on the line in the new year when Royal Bank of Scotland will announce further shrinkage of the investment banking arm that is blamed for the £45bn taxpayer bailout – the biggest in the world.

But the chancellor used his statement to MPs to seize upon an existing overhaul of the investment banking arm of RBS, promising "further significant reductions" in a division that employed more than 25,000 staff before the 2008 bailout.

The headcount has already fallen to 18,000 and analysts such as Ian Gordon, of Evolution Securities, reckon at least another 5,000 will be axed.

Analysts said the downturn in market activity due to the eurozone crisis was hitting investment banking but that the proposals outlined by Vickers' Independent Commission on Banking (ICB) were also making it tougher to run the business as it would need to hold more capital.

Osborne, who also pledged to follow Vickers' recommendation to separate high street banking from investment banking, spelt out his views to MPs: "We believe RBS's future is as a major UK bank, with the majority of its business in the UK and in personal, SME [small and medium-sized enterprises] and corporate banking. Investment banking will continue to support RBS's corporate lending business but RBS will make further significant reductions in the investment bank, scaling back riskier activities that are heavy users of capital or funding."

Analysts reckon that RBS, which has called in the McKinsey consultancy, could end up shutting its equity business – Hoare Govett – and closing down its risky structured products to focus on currencies, money markets and trade finance. Hester has said previously that he thought there would be few buyers for the investment bank.

The taxpayer is sitting on a £27bn loss in its 83% shareholding in RBS. Osborne said that "British people are angry about what happened in our banks, and angry at the politicians who let it happen" as he launched another attack on the shadow chancellor, Ed Balls, whom he said had given Sir Fred Goodwin, the former boss of RBS, his knighthood.

Promising that the UK would remain a global financial centre, Osborne told MPs the coalition would adopt the proposals from the ICB that would help to tackle the "British dilemma": banks are too big, with balance sheets equivalent to 500% of GDP, but they support 1.4 million jobs. Under the changes:

• High-street banking would be separated from investment banks by a "ringfence".

• Banks would hold bigger cushions to absorb losses, of up to 17% in some cases.

• The number of high-street banks would increase.

Osborne – who set up the ICB under pressure from the business secretary, Vince Cable – promised a white paper would be published in spring 2012, legislation passed by 2015 and the required changes implemented by 2019. This timescale prompted Tony Greenham, head of finance and business at the New Economics Foundation, to warn that this gave "banks years to lobby for laws to be watered down even further".

Vickers, warden of All Souls College, Oxford, welcomed the coalition's decision to back his proposals. "The costs and dangers of unreformed banks are plain for all to see. With the architecture for reform now settled, a more stable structure should now be built," Vickers said.

The chancellor increased the implementation costs of the proposals to between £3.5bn and £8bn – higher than the £7bn upper estimate set out by Vickers. He said the reduction in the likelihood or impact of future financial crises would cause an incremental economic benefit of £9.5bn a year. The government estimates the annual cost to GDP would be £0.8bn-£1.8bn – equivalent to 0.1% of output.

Businesses are concerned the costs of will be passed on to them. John Longworth, director general of the British Chambers of Commerce, said: "Businesses still find it difficult to get access to capital, or capital on reasonable terms, in what is a highly risk-averse environment. This creates the danger of slowing the recoveryand it is possible that Vickers' recommendations could add to this problem. Given the timescales for the implementation of credit easing, the time may now have come for the government to consider the introduction of an SME Bank."